Today’s trading session was the first of the new compliance year (2012-13). Both volume and price expectations were low, given that there is no real pressure on the obligated entities to buy this early in the year. Considering that, both prices and volumes surprised – IEX and PXIL traded price was Rs 2,201/ REC (32% higher than the floor price of Rs 1,500; we believe that prices and volume this month are not comparable with March 2012 as the drivers for buyers and sellers were very different last month).

The total demand was for 263,913 RECs. This appears high compared to last month (demand last month was for 389,000 RECs; last April was 260) given that this is the first month of the compliance year.
Supply was impacted by low issuance of RECs (118,000 in April vs 204,000 in March) likely due to reduced urgency on part of generators to claim RECs. Total available RECs were 157,000, of which 133,000 were bid for sale (85% participation). At this stage in the market, the participation level was high. Of the total bid for sale, only 54% were sold indicating seller’s willingness to hold and expectation of even higher prices later in the year.

With the new floor and forbearance price from this financial year coming in picture, today’s price will bring some smile on the sellers. The relatively high demand and prices are an indication of expectation of enforcement.

AD played a key role in building the vast wind base that India has developed – India has more than 16,000 MW of wind mills, one of the largest in the world. However, it also led to inefficiencies and small scale projects.

Several factors have led to the removal of AD benefit:

The wind sector already has scale. The market has been steadily moving towards an Independent Power Producer (IPP) model for some time. IPP based projects do not get AD benefit – instead they avail Generation Based Incentives (GBI). However, investments based on AD remained significant (according a Bloomberg article AD based investments accounted for 70% of total in 2011).

The removal of AD was a part of the larger cleanup of the Direct Tax Code.

Small scale investments led to inefficiencies and sub-optimal asset utilization. For example, many companies own a single or few wind turbines, often no more that a few hundred kilowatts in capacities. In contrast, IPP often aim to develop several hundred megawatts.

This change will change the industry structure significantly. At present, companies selling WTGs sold the whole package – land, approvals, WTG (ofcourse), erection and commissioning and day-to-day management of the wind farm. This catered primarily to the small investor who was in it for the AD benefit. IPPs tend to work differently, preferring to select different vendors for each task and often managing the asset very proactively.

Under the AD benefit, companies could claim 80% depreciation in the first year itself. With the benefit gone, they will be eligible for 15% (the rate in the Income Tax act for Plant and Machinery). They are also likely to be eligible for a further 20% available to power equipments. Thus, the total depreciation benefit will be 35%. In other words, a significant asset like the WTG can be depreciated in 3 years – not a small benefit at all in absolute terms.

Its important to note that AD benefit will continue for Solar projects. It will be interesting to watch the solar industry now, and at least some of the investment that would have traditionally gone into wind may now shift to Solar. A critical factor in that would be the emergence of a Suzlon-equivalent in the Solar space – a company that can package the whole thing for the small investor.